Safeguards and Sustainability of Air Services – Protection for Whom, From Whom?

Dr. Peter P. Belobaba

Concordia University and MIT

March 2003

Deregulated, Not Fully Competitive Open Markets

• Since US deregulation, pressure for less government control over airline markets has spread worldwide:– A result of the perceived overall success of US deregulation and

other experiences in Canada, Australia, Europe and elsewhere

• Deregulation has not meant totally free competition:– Gave freedom to airlines to choose routes, frequencies, and prices in

domestic markets with less government intervention

– But, operational and safety regulations remain, through airline certification, crew training requirements, maintenance standards, etc.

– Bilateral agreements still limit access to international markets

– Ownership restrictions limit ability of airlines to raise foreign capital

– US airlines still required to operate certain “essential air services”

– Other regulations govern CRS/GDS distribution channels

US Deregulation Experience Generally Positive

• Overall benefits have been clearly demonstrated:– US domestic air travel more than doubled in first ten years of

deregulation, a growth rate well above pre-deregulation times

– Average real (inflation adjusted) air fares continue to decline today

– Development of some very successful new low-fare carriers, with rapid growth in recent years (e.g., Southwest, AirTran, JetBlue)

– No statistical evidence of reduced airline safety

• But some parties have suffered:– Labor unions experienced reduced power, jobs and wages

– Greater disparities in fares paid by business and leisure travelers

– Small cities saw commuter airlines replace larger jets

– Profit volatility and bankruptcies raise questions about airline investment and sustainability of traditional airline operations

Changed Competition Under Deregulation

• The removal of economic regulations has added new dimensions to airline competitive strategies:– Cost cutting and productivity improvement

– Economies of scale in operations to reduce unit costs

– Price competition and revenue management to increase revenues

– New marketing and distribution programs

– Increased network coverage and market dominance

• Quite simply, airline managers now actually have to make management decisions and trade-offs:– In contrast to regulated times when government control ensured

price increases to cover increased operating costs.

– “Airline management” was relatively easy under government regulation and subsidization of flag carriers

The March Towards Global Liberalization

• Overall success of the US experiment has led other countries to deregulate domestic airline markets:– Australia and Canada were among first to follow

– Japan, Brazil, United Kingdom loosened restrictions

– European Union has also moved toward “open skies”

• Although differences exist, many similar impacts have been observed in deregulation outside the US:– New entrants with lower costs and fares, that face stiff competition

and potentially predatory practices from incumbent airlines

– Potential for volatility and destructive competition arises, especially in periods of reduced demand and excess capacity

– Recent dramatic shifts in airline industry have begun to shift momentum of change to low-cost, low-fare new entrants

Protection of New Entrant Airlines

• Initial efforts by new entrants to compete were in effectively rebuffed by larger incumbent airlines:– Incumbents had significant advantages of frequency, network

coverage, service quality, and frequent flyer programs

– Revenue management systems allowed incumbents to match new entrant’s fares while limiting revenue dilution, offering better value

• Aggressive responses by incumbents in some cases raised questions of “unfair” competition:– Lower fares and/or increased capacity to drive out new entrant

– Potentially predatory actions, subsidized by revenues from other parts of incumbent’s network

– Hoarding of gates and/or slots to prevent new entry and growth

• Led to serious policy discussion for “re-regulation”

The Remarkable Growth of Low Fare Carriers

• Recent conditions favorable for low-fare airlines:– Less business travel overall; reduced willingness to pay for

premium services; reduced quality of traditional airlines

– More stable demand for price-sensitive leisure travel, primarily in high density point-to-point markets

– Greater awareness of low-fare options through internet channels, and growing acceptance of “alternative” air travel services

• Low-fare carriers now threaten viability of traditional network airlines:– Share of US domestic passengers flown by low-fare carriers

increased to 20% in 2002, from 16% in 2000 and only 5.5% in 1990

– Largest low-fare carriers increased both capacity and traffic in 2002, in sharp contrast to most traditional network airlines

Who Needs Protection Now?

• In North America and Europe, legacy airlines now face unprecedented operating losses:– Major airlines are looking for new “business models” to respond to

changed environment and to compete with low-fare airlines

– Low-fare competition, combined with Internet distribution and inability to support revenue differentials mean no pricing structure alone can return legacy airlines to profitability

– After 2 decades of deregulation, US Major airlines now finally face the reality that their cost structures are simply unsustainable in a competitive environment

• Protection for new entrants has become moot:– Southwest, JetBlue, RyanAir and EasyJet are among most

profitable airlines in the world, while legacy airlines declare bankruptcy

– Government intervention to protect legacy airlines now a possibility

When Is Protection Warranted?

• Government intervention to “protect” airline services might be warranted in limited cases:– Sustainability of airlines and assurance of air services in

developing countries

– Where tourism-supported economies depend on air services

– Isolated or remote communities requiring air services for movement of population and goods

– Under conditions of catastrophic national/global events or war

• Even in these situations, not clear that inefficient air carriers should be supported or protected:– Government regulations and (even worse) financial support

inevitably cause market distortions and inefficiencies

– In most situations, development of new services, by new airlines, with more efficient operating models will ultimately fill any void

Sustainability, Not Protection of the Status Quo

• Very real need for sustainable air services must not be used as an excuse to prolong inefficiency:– Need for national flag carriers, fear of losing air services often cited

as reasons for government protection

– Yet, highly regulated national flag carriers have been among the most poorly managed and least efficient airlines in the world

– Experiences throughout the world have demonstrated how open market conditions ultimately lead to sustainability and efficiency

• A balance between effective safeguards and unnecessary protection is required:– Recognize that many essential air services can and will be provided

by more efficient carriers, given reduced regulatory constraints

– In nobody’s long-term interest to support and protect inefficient air carriers – emphasis should be on sustainability AND efficiency